When the history of monetary policy over the past five years is written, the observers that look back will ask whether 2013 marked the beginning of the end of central bank independence. For decades, rules were increasingly put into place to clarify the relationship between a central bank and government. Day to day decisions would be entirely left in the hands of central bankers. Longer term policy strategy was to be decided by the politicians, preferably in consultation with the policy experts. We have been seeing some of this understanding being turned on its head as central bankers appear to be taking the lead in developing and implementing new policy strategies, it seems by default.
Elections in Japan brought about a change in government where the party now in power is determined to direct the Bank of Japan (BoJ) to more aggressively re-inflate the economy. Indeed, the new government is demanding ‘unlimited’ monetary easing without a clear idea — actually no idea at all as far as I can tell — about how this is supposed to work in practice. During the election campaign, Japan’s recently installed prime minister complained that “…the traditional methods [of monetary policy] have not been able to defeat deflation for more than a decade. That’s not good” (Dickie 2012). Never mind that the BoJ has long claimed that it is at the forefront of unconventional monetary policies (see, for example, Governor Shirakawa’s 2010 speech). Politicians occasionally seem deaf to the attempts by central banks to promote economic recovery and their own failure to take their share of responsibility for policy making.
In the euro zone, the ECB’s Outright Monetary Transactions program has calmed markets but the crisis in the euro zone is far from over. No one knows whether the conditionality that would permit a country such as Spain, or even Italy, to receive financial support from the ECB can be enforced. In the US, now that elections are behind us and politicians are more concerned with the economic consequences of their fiscal actions or inactions, Fed bashing has receded from the front pages while the central bank remains concerned that recovery in the US is likely to remain weak. In the UK, a brief return to recession has prompted more quantitative easing while the appointment of a Canadian as the incoming Governor of the Bank of England has led to musings about a change in the monetary policy strategy away from inflation targeting. In each case it seems that central banks, staffed by technocrats and accountable to the public via the governments they serve, are consistently asked to lead policy-making while their political masters kick the proverbial ‘can down the road’. Indeed, the President of the Bundesbank, in a year-end interview, complains that “…I find it strange that politicians, who should be leading the way and making decisions, wish to file behind us [i.e., central bankers] and be guided by us” (the interview with Jens Weidmann can be found here).
As far as monetary policy is concerned we live in a strange new world. The institutional separation between fiscal and monetary policy that is the staple of textbooks, and countless academic papers, is no longer seen as tenable or even desirable. This is as it should be, at least in a crisis. After all, in depressed times, monetary policy should be seen as supporting a government’s economic policies aimed at achieving a full economic recovery. Nevertheless, what is dismaying is that politicians and central bankers do not give the impression that they are coordinating their policies to ensure that economic activity returns to something resembling normality. Instead, the world appears to be waiting for the next ‘unconventional’ policy pronouncement by central bank officials. If central bank independence as it is currently understood is being sidelined the reasons should be articulated.
Having adopted en masse loose fiscal policies, politicians in the advanced world are now retreating behind a desire, at virtually any cost to it seems, to impose various forms of austerity programs. Any inkling that policy makers and their political masters are working as if they are ‘all in this together’ seems lost. Indeed, we hear politicians complaining either that central bankers are not doing enough — why is monetary easing not helping the economy recover faster? — or that the monetary authorities are being reckless and too activist with much higher inflation just around the corner, in spite of the fact that output gaps remain large and the source of higher future inflation is fuzzy at best. Of course, there is more than one kind of inflation. We are not seeing a sharp rise in consumer price inflation but we have relatively little idea how much loose monetary policies are contributing to inflation in asset prices and distortions in financial markets. Central bankers are quite right when they argue the need to do ‘whatever it takes’. However, this is more a reflection of the failure of governments and their legislatures than a sign of the promise of central bank independence. The fact that governments’ own actions and policies may be contributing a good deal to the ongoing economic harm is not considered.
To be sure there are some exceptions to the above developments. In Canada, the Finance department and the Bank of Canada have made several joint announcements in their attempts to cool consumer borrowing and mortgage lending (with mixed success it has to be said). But the exceptions are rather few. As a result, we are witnessing a deterioration of policy making at the highest levels. Of course, if all turns out well in 2013 the ongoing conflicts, open or hidden, between central banks and governments will be quickly dismissed. But, if the global economy continues to struggle, there will be a moment when more politicians issue ultimatums of one kind or another of the Japanese variety, possibly disguised through legislative action or threats to direct central bankers to change their policies. At that moment, the promise and peril of central bank independence and what it is supposed to represent will become clearer to everyone.